BEGINNING A DEAL: NONDISCLOSURE AGREEMENTS AND LETTERS OF

© 2016 Morgan, Lewis & Bockius LLP

BEGINNING A DEAL:NONDISCLOSUREAGREEMENTS ANDLETTERS OF INTENTJohn Utzschneider

September 20, 2016

Confidentiality Agreements

Topics Covered

• Initial Considerations

• Contents of a Confidentiality Agreement

• Sample Provisions

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Initial Considerations – Topics to Cover

• Why have a written confidentiality agreement?

• Are you more likely to receive or disclose information?

• Unilateral vs. mutual?

• When to enter into a confidentiality agreement

• Separate agreement or part of the term sheet?

• Is the disclosing party a public company?

• Limitations on effectiveness of confidentiality agreement

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Why Have a Written Confidentiality Agreement?

• Confidentiality agreements are standard and an expected part of most negotiated deals

• Protection of trade secrets under state law can be lost (deemed waived) if they aredisclosed without a written agreement

• Written contracts are typically easier to enforce

• Written confidentiality agreements are often required under prior agreements with thirdparties

• They avoid confusion over what the parties consider to be confidential

• The parties have more flexibility in defining what is confidential

• The parties can specify what they expect from each other

• Confidentiality agreements often cover issues unrelated to confidentiality, such asnonsolicitation and exclusivity and absence of binding commitments to complete atransaction

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Are You More Likely to Receive or Disclose Information?

• A simple question with big implications

• Whether you are primarily disclosing confidential information or receiving confidentialinformation will drive some of your strategy for the structure of the confidentialityagreement

• A Buyer’s interest is different from a Seller’s interest

• Buyer’s Interest:

• A Buyer typically wants the exclusions from confidential information to be as broad aspossible and permission to disclose all confidential information to Buyer’s advisors andrepresentatives and any financing sources

• Seller’s Interest:

• A Seller typically wants the Buyer’s exclusions to be as narrow as possible and, to theextent possible, to exert control over the sale process through confidentialityprovisions

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Unilateral vs.

Positive:

• Restricts the disclosing party only

Challenges:

• Does not protect confidential informationof the other party that may be disclosedlater

• Does not protect nonbusiness information(such as deal terms or deal process) thatboth parties will likely want to keepconfidential

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Mutual

Positives:

• Protects confidentialinformation of both parties

• Protects nonbusinessinformation about the actualdeal

• Provides a more balanced formthat typically results in a fasterreview and signing process

Challenge:

• Imposes restrictions on bothparties to the transaction,regardless of which party hasmore leverage in the deal


When to Enter into a Confidentiality Agreement

• As soon as possible

• Prior to disclosure of any confidential information

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Practice Tip

If disclosures of confidential information have been made prior toentering into a confidentiality agreement, make sure that theconfidentiality agreement specifically covers all prior disclosures


Separate Agreement or Part of the Term Sheet?

Having a separate confidentiality agreement:

• Gives the parties the flexibility to conduct due diligence of certain nonpublicinformation before negotiating a term sheet or letter of intent

• Is typically easier to negotiate

• Provides the parties with written protection in the event of disclosure ofconfidential information prior to entering into a term sheet or letter of intent

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Practice Tips

• Confidentiality provisions included in a term sheet or letter ofintent should be made expressly binding on the parties

• A separate confidentiality agreement should be incorporatedby reference in the term sheet or letter of intent


Is the Disclosing Party a Public Company?

If you answer “YES” to this question, then consider the following:

• Include a standstill agreement in the confidentiality agreement restricting Buyer’sunsolicited bids for the Seller

• Obtain a representation that the recipient and its representatives are in compliancewith securities laws (or, at a minimum, are aware of their obligations undersecurities laws)

• Determine whether the terms of the confidentiality agreement qualify forRegulation FD under the Securities Exchange Act of 1934, as amended – shouldqualify in most circumstances

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Limitations on Effectiveness

• The disclosing party cannot “undisclose” confidential information that has beenwrongfully disclosed and has become part of the public domain

• The disclosing party’s remedy for wrongful disclosure of confidential information islimited and damages for breach of contract may be the only legal remedy

• The disclosing party has the burden of proof with respect to proving that a breach hasoccurred

• The disclosing party may not be able to effectively prevent the recipient of confidentialinformation from inevitably taking the confidential information into account in its owncommercial plans

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Practice Tip

To protect confidential information, the disclosing party should carefullymanage the disclosure process, consider additional confidentialityprocedures for extremely secretive information, and have a contingency planfor dealing with leaks


Contents of a Confidentiality Agreement – Topics to Cover

• Parties to the confidentiality agreement

• Definition of confidential information

• Exceptions to confidentiality

• Permitted use and restrictions on disclosure

• Issues with direct competitors

• Term

• Return of confidential information

• Remedies

• Other covenants/provisions

• No representations or warranties

• Nonsolicitation

• Standstill agreement

• Trading on securities

• Public announcements

• Exclusivity

• Residual rights

• Miscellaneous provisions

• Enforcement/forum/jury trial waiver

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Parties to the Confidentiality Agreement

• The principal parties to the transaction are the Buyer and Seller/Target.Occasionally, investment banks will enter into the confidentiality agreement onbehalf of a Seller.

• Representatives of the principal parties usually have access to the confidentialinformation.

• Most confidentiality agreements limit disclosures to third parties but permitdisclosures on some basis to “Affiliates” and “Representatives” (both of which arenegotiated terms).

• The disclosing party typically asks that the recipient be responsible for unauthorizeddisclosures by its Representatives. For example, the disclosing party can include ageneral provision holding the recipient responsible for its Representatives or it canrequire that the Representatives sign an acknowledgment to be bound by theconfidentiality agreement.

• If the recipient is a holding company or part of a larger corporate structure, theseprovisions often makes it clear that the recipient is responsible for the acts of itsrepresentatives and Affiliates

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Parties to the Confidentiality Agreement

• Many recipients resist requiring their Representatives to sign confidentiality documentsand instead prefer to be directly responsible for their actions

• Requiring attorneys, accountants, and other professionals to enter into separate writtenagreements can be time consuming and delay the due diligence process

• Trend:

• Financial buyers prefer to have their financing sources enter into confidentialityagreements directly with the Sellers so that the Buyers are not responsible for anybreach by those financing sources

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Practice Tips

• Even when not required by agreement to do so, Buyers and Sellers often have theirRepresentatives enter into separate confidentiality agreements or acknowledge theterms of the confidentiality agreements as a matter of practice

• Note that certain Representatives (such as lenders, investment bankers, and lawfirms) may not wish to be bound by certain sections of the Buyer’s or Seller’sconfidentiality agreement, such as the standstill or nonhire provisions


Definition of “Confidential Information”

• Defining what is confidential is central to any confidentiality agreement

• The types of matters that are typically categorized as confidential include:

• Business information (including trade secrets)

• Derivatives of business information

• The contemplated transaction itself, including any terms

• Labeling disclosed information as “Confidential” or not labeling disclosed information?

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Practice Tips

• The confidentiality agreement should make it clear when confidential information isbeing disclosed.

• If the confidentiality agreement requires certain steps to be taken for information to beprotected, such as marking the information as confidential, the disclosing party mustbe very careful that this process is followed. In general, providers of confidentialinformation should resist this requirement.

• Disclosing parties must also be careful not to disclose information that is restricted byother confidentiality agreements.


Exceptions to Confidentiality

• Almost all confidentiality agreements provide certain exclusions to the confidentialityobligations

• Many of these exclusions are fairly customary and include information that:

• Is or becomes public other than through a breach of the confidentiality agreement bythe recipient

• Was available to the recipient on a nonconfidential basis before disclosure

• Was already in the recipient's possession

• Becomes available through a third party not bound by a confidentiality agreement orobligation

• Is independently developed by the recipient without using the confidential information

• Buyers usually require that all of these exclusions apply to the ”Confidential Information”definition generally and not just to the “nondisclosure” provisions

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Other Common Exceptions to Confidentiality

• Disclosing the existence and terms of the deal to a bank or other lending source to securefinancing

• Disclosures required by law

• Confidentiality agreements usually allow the recipient to disclose confidential informationif required to do so by court order or other legal process

• The recipient usually has to notify the disclosing party of any such order and cooperatewith the disclosing party to obtain a protective order

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Practice Tip

• In negotiating a confidentiality agreement, always keep in mind the distinctionbetween restrictions on disclosure and restrictions on use, and the associatedexceptions.


Permitted Use and Restrictions on Disclosures• The disclosing party should:

• Clarify how the information can be used, and who may see it

• Make it clear that the information can only be used for a specific purpose, such as the evaluation ofthe current transaction

• A Seller will try to narrowly define the nature of the proposed transaction – for example a“negotiated acquisition” (which could act as a limit on the Buyer’s ability to launch a hostile bid)

• The recipient of the information must make sure that the scope of the permitted recipients issufficient to conduct due diligence and obtain financing commitments (if applicable)

• Backdoor Standstill

• Martin Marietta Materials, Inc. v. Vulcan Materials Co., 56 A.3d 1072 (May 4, 2012) (highlighting thefact that a failure to clearly define how a recipient may use or not use the target’s confidentialinformation received during the course of a deal could effectively create a backdoor standstill,prohibiting the recipient from pursuing a hostile deal while the confidentiality agreement is in effect)

• Clarify who is permitted to access and use the information

• Include the recipient's affirmative duty to keep the information confidential. This duty isoften tied to a certain standard of care

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• Anticlubbing and Financing

• Sellers will focus on these provisions to better control the sales process

• More common in deals with one or more private equity Buyers

• Prohibit the practice of consortium bidding or “clubbing”, which is the acquisitionstrategy of forming a group of bidders to collectively participate in an acquisition

• The Seller may request that the Buyer make a representation that it is not a party toany exclusivity (or lock-up) arrangement with a potential source of financing

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Issues with Direct Competitors

• What level of information should the parties disclose if they are direct competitors?

• Consider business and legal (antitrust) risks

• Direct competitors should consider the following when contemplating the terms of aconfidentiality agreement:

• Disclosures may be limited to aggregated information, or sensitive information may otherwise bemasked

• For sensitive information, consider signing a separate nondisclosure agreement (NDA) and a “cleanteam” approach with much more specific provisions and controls regarding the disclosure of suchinformation

• Avoid reviewing any documents that may lead to a claim of misappropriation of information

• Be sure to check whether sharing certain information with a competitor violates any antitrust laws; aviolation could kill the deal or result in regulatory action

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Term• Indefinite or termination upon a certain date or event

• Depends on the type of information involved and how fast such information changes

• Disclosing parties typically prefer an indefinite period

• Recipients typically prefer a set term

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Practice Tip

• Be sure to set specific expiration dates for those provisions that are not related toconfidentiality obligations (for example, standstill agreements or nonsolicitation clauses)


Return of Confidential Information• Confidentiality agreements typically provide for the return of confidential information in

the following circumstances:

• On the termination of negotiations between the parties

• At the end of the term of the agreement

• At any time upon the disclosing party's request

• Recipients often want:

• The option to destroy the confidential information instead of returning it to thedisclosing party

• To include language that allows them to keep copies of the confidential informationfor archival or evidentiary purposes or if required to do so under law or professionalstandards

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Practice Tip:

• Disclosing parties should make sure they have rights to the return of their confidentialinformation or an adequate process to confirm destruction or archival undersatisfactory procedures


Remedies• Injunctive relief in addition to monetary damages

• Indemnification provision holding the recipient responsible for all costs relating to theenforcement of the agreement

• Recipients will resist including the indemnification provision

• A typical compromise is to have the losing side to a dispute pay the fees andexpenses (including legal fees)

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Other Covenants/Provisions• No Representations or Warranties

• The disclosing party may clarify that it makes no representations or warranties with respect to any of thedisclosed information. If the recipient claims that the information is incomplete or inaccurate in any way, thedisclosing party points to this clause to avoid liability.

• Nonsolicitation / Nonhire

• Restricts the recipient from soliciting and/or hiring the disclosing party’s employees for a certain period of time(one year is common). Parties will negotiate whether this is nonsolicitation or nonhire, and whether it applies toall employees or just more senior people.

• Sometimes will restrict the recipient from soliciting the disclosing party’s customers and suppliers.

• Standstill Agreement

• May be included in the confidentiality agreement when the Seller is a public company.

• Helps the Seller to control the sale process.

• Prevents the prospective Buyer from making a hostile takeover attempt after the parties fail to complete afriendly deal when the Buyer has had access to the Seller’s confidential information.

• Often limits the Buyer's ability to buy and sell the Seller's stock.

• Buyers often seek to limit the term of the standstill to a period typically ranging from 6 months to 18 months.

• Sometimes includes a “don’t ask, don’t waive” provision limiting a Buyer from requesting a waiver of thestandstill. This may raise issues about the adequacy of the sale process and the Seller board’s fulfillment of itsfiduciary duties and should be reviewed carefully.

• Buyers may also seek to have the standstill “fall away” in certain circumstances, such as once the Seller signsup a deal with another party, or if the Seller becomes subject to a “hostile” bid, to preserve Buyer’s options.

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Other Covenants/Provisions• Trading in Securities

• Use when the disclosing party is a public company.

• Reminds the parties of their obligations under securities laws.

• Keeping quiet about the deal

• Prohibits the parties from making a public announcement or other disclosure aboutthe deal unless agreed to in advance by both sides. Both sides can have aninterest in keeping negotiations quiet.

• Exclusivity

• Sometimes referred to as a no-shop clause, this provision requires the Seller todeal exclusively with the Buyer for a certain period of time.

• Exclusivity agreements are usually separate agreements or sometimes included inthe term sheets/letters of intent for deals.

• Can be problematic for a public Seller, depending on the length of the exclusivityperiod and size of the deal.

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Other Covenants/Provisions• No license granted

• Obligation to inform of unauthorized disclosure

• No further obligations

• Residual rights

• Residual rights clauses allow the recipient's employees to use any confidentialinformation retained in their memories

• Sellers often strongly object to residual rights clauses and have concerns overabuse

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Practice Tip:

To limit potential abuse, some residual rights provisions state that employees cannot“intentionally” remember information to sidestep confidentiality obligations


Miscellaneous Provisions• Often viewed as “standard” or “boilerplate” but may have unintended consequences, restricting the

Buyer’s activities in the industry and the Buyer’s options as the negotiations progress, even if atransaction never materializes

• Terms may prove very consequential in the event of a subsequent dispute between the parties

• Topics include

• Entire agreement

• Assignment, especially the ability of Seller to assign agreement to another acquiror of business

• Choice of law and jurisdiction

• Waiver of jury trials

• Availability of equitable relief

• Notice provisions

• Amendments and waivers

• Override of other confidentiality agreements (for example, in data rooms)

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Practice Tip:

Parties often switch governing law as part of the negotiations. Don’t select a governing lawunless someone knowledgeable about that law has confirmed it raises no issues.

Letters of Intent

Topics Covered

• Preliminary Considerations

• Why Sign a Letter of Intent?

• Why Not Sign a Letter of Intent?

• Contents of a Letter of Intent

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Letters of Intent

Preliminary Considerations• Watch out for unintended binding contracts

• Context is very important

• Indication of interest

• Stand-alone “working” term sheet

• “LOI,” “MOA,” “MOU,” “heads of agreement”

• “Straight to definitives”

• Bilateral negotiations

• Auction process

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Practice Tips

• Prior to negotiating a Letter of Intent (LOI), think through and assess:

– Why are we negotiating an LOI? Is my side better off just signing anNDA and (maybe) an exclusivity agreement, rather than an LOI?

– If an LOI will be prepared, is my side better off with a more detailed/lessdetailed LOI or more binding/less binding LOI?

Letters of Intent

Why Sign a Letter of Intent?• Key considerations

• Level of detail and process to get external and internal “buy-in” to deal and the basicterms

• Either party’s desire to confront certain issues at certain points in the negotiationsbefore incurring substantial deal expenses or devoting significant time dealing withthe counterparty

• Required disclosure

• Presigning binding covenants

• Develop a “roadmap” for the transaction

• The Seller sees a level of commitment before disclosing confidential information

• The Buyer can obtain exclusivity, break-up fee, expense reimbursement provisions

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Letters of Intent

Why Not Sign a Letter of Intent?• Time to negotiate – could spend this time on negotiating definitive documents

• Enforceability considerations

• Obligation to negotiate in good faith

• Creates inflexibility on terms of proposed deal – may prematurely lock in parties toterms they later don’t like

Private vs. Public Company Issues• Possible disclosure issues if a public company signs a letter of intent for a material

transaction• As a way to address disclosure issues, parties may use an exclusivity letter with a

separate unexecuted term sheet

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Practice Tip:

The most important item in any letter of intent is making sure that the descriptions ofwhich items are binding and which are not accurately matches the parties’ intent.Also, confirm that the language about waiving or amending the letter of intent’s termsis appropriate (for example, no oral waivers or waivers by course of conduct).

Letters of Intent

Contents of a Letter of Intent• Parties to letter of intent

• Consider execution by significant shareholders, especially if the Buyer is a shell

• Level of detail varies a lot from deal to deal depending on the parties’ desire todocument deal terms in detail up front

• Description of transaction

• Stock/asset/merger

• Price

• Buyer financing, seller financing, holdbacks, earn-outs

• Purchase price adjustments

• Net working capital, net worth

• EBITDA

• Noncompetition agreements

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Letters of Intent

Contents of a Letter of Intent• Conditions to transaction

• Standard

• Execution of definitive documentation

• Third party consents, completion of diligence

• Deal specific

• Special accounting, environmental issues

• Financing

• Employment arrangements

• Lists of representations/warranties, indemnification, survival

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Letters of Intent

Contents of a Letter of Intent• Exclusivity

• Binding

• Fiduciary out

• Break-up fee, reverse break-up fee, expense reimbursement, and related issues

• Other binding LOI provisions

• Conduct of business after execution of letter

• Access

• Expenses

• Publicity

• Termination

• Binding and nonbinding provisions

• Implied duty to negotiate in good faith

• Waiver of jury trial

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Practice Tips

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• Parties should be careful not to undo useful “nonbinding” language in theLOI through conduct indicating a binding commitment.

• Consider adding a provision eliminating any implied duty to negotiate ingood faith. As an alternative, minimize the impact of any implied duty byadding unilateral termination provisions to the LOI or outside terminationdates.

• Even though the LOI may be nonbinding, prepare for disputes – consideradding jury trial waiver, governing law, forum selection clause.

Biography

John R. Utzschneider

Boston

T: [email protected]

John Utzschneider focuses primarily on mergersand acquisitions, securities offerings andcorporate governance and finance, includingdebt restructurings. He represents both privateand public companies, equity and debt financingsources and underwriters in mergers andacquisitions, leveraged buyouts, joint ventures,private and public offerings, and restructurings.Chambers USA 2014 describes him as extremelybright and responsive and able to deliver “top-notch and efficient legal services.” John has beenlisted for many years to various peer-reviewedbest lawyer lists in various categories, includingChambers USA, Best Lawyers in America, andLegal 500.

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Documents

BEGINNING A DEAL: NONDISCLOSURE AGREEMENTS AND LETTERS OF